Asset Management Guide: Operator Search

International hotel operators: how to choose one

One aspect I have been focusing on lately is the operator search and contract negotiations. We prioritise this process to ensure that we get the best fit for each property and that we achieve the highest yield for our investors. Dubai is one of the world's most attractive markets for international hotel operators, with a huge number of properties in the pipeline and countless opportunities for these firms to expand their brand presence.

Feasibility Phase: Once a development has been secured and appointed to our team, the first task is to determine the hotel criteria, such as room mix, F&B outlets, leisure facilities, etc. We undertake an in-depth analysis of the market to identify niches that can be filled that will prove crucial to the hotel's long-term success. The first step is to understand current and future supply. Evaluating demand factors and the potential business mix for the property by using market data is key to developing a viable business model. From this analysis, we can then derive a detailed area schedule for the project.

Initial Selection of Operators: The next step is to identify a hotel operator that will have the best chance of success managing the property.

It is important to prioritise operators that already have a presence in the market. It helps to evaluate their current performance and use it as a benchmark.

Using a brand matrix, we will identify 12 to 15 prospective brands to create our initial list. Following a comprehensive analysis, we will create a shortlist of five to eight operators.

When selecting an operator, we must ensure the brand meets the owner's expectations. Not all brands are suitable for certain owners.

When approaching potential operators, the asset manager should send each a Request for Proposal (RFP) highlighting the unique selling points of the project. This document includes a brief description of the owner, area schedule, preferred business model, project location and a brief market analysis outlining its potential.

It is important to engage with each operator's development team. Through these discussions, the asset manager will better understand the operator's decision-making processes, its speed in responding to requests, its approach to the market, and many other insights.

The management agreements will have a term sheet that includes multiple clauses that need to be revised and compared with the financial forecasts.

The following are typical clauses found in a hotel agreement.

Term – Length of Contract

Management Fees - Fees paid to the operator

Base Fee – Percentage of gross revenue

Incentive Fee – Percentage of profit

Royalty Fee – Compensation for the use of the hotel's brand name, logo and service marks, base as a percentage of gross rooms revenue and in some case total gross revenue.

Reservation Fee – Fees to support the cost of the central operations' office reservations system.

Sales and Marketing Fee – Fees for brand sales & marketing campaigns charged to the owner based on rooms or gross revenue.

Loyalty Fee - Fees for using the operator's loyalty programme and the cost of points and indirect costs due to redemption (ADR impact).

Licence Fee – Fees for logo and image rights based on gross revenue.

Furniture, Fixtures and Equipment Reserve (FF&E Reserve) – An amount deducted from the P&L and held in an escrow account, typically a percentage of revenue for future upkeep of the property.

TSA Fee - Fees paid to the operator for technical expertise; these are incurred during the design and building phases to ensure the project is delivered to brand standards.

Budget Approvals – The right for the owner to access the budget and have approval rights over it.

Owners Priority Agreement (OPA) – An amount or percentage paid to the owner before the incentive fee is paid.

Owners' guarantee – A fixed amount funded by the operator, in case of a shortfall in profits.

Termination – The terms under which the owner can terminate the agreement with the operator and vice-versa.

Keeping in mind the owner's expectations, the asset manager aims to create the most beneficial agreement for both parties, ensuring the operators are not overcompensated for their work and the owner's interests are well protected. While owners will always seek to pay the smallest fee possible, it is also in their interest that the operator is rightly compensated to motivate them, leading to better results.

When negotiating a fee structure, we recommend prioritising compensation that is linked to performance. For example, we would recommend higher incentive fees that are based on Gross Operating Profit (GOP) as opposed to higher base fees linked to top-line results, as this incentivises operators to strictly control expenses.

During this process, we obtain feedback from the owner in order to align their objectives with those of the operator. The final step is to sign a Letter of Intent (LOI). Once the LOI is signed, the legal teams negotiate the specificities of the management contract. Securing an operator is a complex process that typically takes anywhere between nine to twelve months. It is vital an experienced asset management team manages the process. An experienced team will take into account the priorities of operators and owners and will work to reach a mutually beneficial agreement in a short timeframe. A hotel management agreement is a long-term commitment between the operator and owner. It is vital the right agreement is put in place to avoid any potential problems in the future.

Mariano Faz is Head of TFG Asset Management in Dubai. www.tfgassetmanagement.com. He is
responsible for the asset management of the company’s Hospitality and Real Estate portfolio which
comprises over 3,000 units in the UAE and an additional 3,000 hotel units under development.
During his tenure, Mariano has guided the strategic planning efforts to achieve investment objectives
on behalf of owners.